1. Discussion of Operating Expense Caps and Other Expense Considerations Resulting From the FCC’s Universal Service Fund Reform Order
Prepared by Doug Kitch, Principal, CPA
Alexicon Telecommunications Consulting
May 2016

2. Agenda Operating Expense (OpEX) Caps
Further Notice of Proposed Rulemaking
Conclusion

3. Operating Expense Caps
Background
Carriers should be prudent and efficient with their expenditures
Corporate expense cap has been in place since about 1996 for HCLS
This cap was extended to ICLS in the Transformation Order
Corporate expenses alone account for about 15% of all loop costs (2013 data)
Leading up to the current Order, the Associations proposed that the Commission adopt limits on OpEX
Associations also proposed comparing all companies’ expense per location to a regression model, plus two standard deviations
The Commission adopted “double log regression” methodology
The Commission ultimately adopted 1.5 standard deviations
As an example: one Alexicon client was disallowed $430,000 of OpEX using two standard deviations, and disallowed $1.489M using 1.5 standard deviations
Reasoning: two standard deviations impacted 17 study areas, while 1.5 standard deviations impacted 50 study areas
Also leading up to the Order, “locations” was used as one of the coefficients instead of “housing units”, which was ultimately adopted

4. Operating Expense Caps
Regression methodology determined/calculated annually
Caps are going to be instituted for all operating expenses, except for depreciation expense, taxes, and [what appears to be] access expense/FUSC
Disallowed OpEX will be phased in over a two-year period: 50% in year one and 50% in year two
It is still unknown when the OpEX caps will be implemented, however it could still possibly be this year
By June 13th, NECA is to submit to USAC 1) a schedule of companies that are impacted by OpEX limits; and 2) the dollar amount of the reductions in HCLS and CAF BLS

5. Operating Expense Caps
Expenses eligible for capping:
Cable and Wire Facilities Expense
Central Office Equipment Expense
Network Support and General Support Expense
Network Operations Expense
Limited Corporate Operations Expense
Information Origination/Termination Expense
Other Property Plant and Equipment Expenses
Customer Operations Expense: Marketing, and Customer Operations Expense: Services

6. FNPRM Review of Permitted Expenses:
Para 349: Adopt guidelines that define what constitutes prudent expenditures (used and useful)?
Starting para 339: Expenses currently not recoverable from high cost funding, and of which the Commission is proposing (not just seeking comment) to also exclude from interstate revenue requirement:
Anything personal in nature
Political contributions/lobbying
Donations, scholarships, penalties, sponsorships of community events
Other/additional expenses the Commission is now seeking to exclude from cost recoveries: artwork; unnecessary vehicles (aircraft, watercraft, ATVs, etc); childcare; cafeterias; housing allowances for employees
Be prepared to substantiate if any of this is necessary

7. FNPRM
Para 345,346: Limitations on compensation for CEO’s and board members?
Para 347: seeking comment on whether to limit or exclude buildings purchased or rented
Affiliate Transactions:
Para 353>: Interested in adopting new rules that provide greater clarity on allocating costs between regulated and non-regulated affiliates
Para 357: seek comment on misallocation of costs; more proper allocation method of reg/nonreg costs
Should SLC cap be raised to permit recovery of amounts not supported by high cost?
Compliance:
Seek comment whether carriers should certify they have not included prohibited expenses in cost submissions
Readdresses the “deemed lawful” provision for prohibited costs
Seeks comments on NECA’s role for enforcing rules for prohibited expenses

8. FNPRM Reducing Support in Competitive Areas
From the Order: Disaggregation of Support in Competitive Census Blocks
Multiple Options:
Option 1: allocate CAF BLS revenue requirement based on density of competitive and non- competitive areas
Option 2: disaggregate using a ratio of competitive to non-competitive square miles in study area
Option 3: disaggregate CAF BLS based on ACAM results for competitive and non-competitive areas
From the FNPRM:
What other methods to disaggregate support?
Based on actual costs
How should non-supported amounts be recovered? Increase SLCs?

9. FNPRM Tribal Support Record is clear
The Commission itself recognizes disparities
Includes a Tribal Broadband Factor, similar to the Tribal Coefficient from QRA
Is requesting/expecting funding, if approved, to be paid out of CAF reserves
Should OpEX be capped at all? Other options/alternatives?

10. FNPRM Streamlining ETC Reporting Requirements From the FNPRM:
From the Order:
For newly served locations, carrier must supply to USAC within 30 days of service the geocoded location and speed information
USAC to establish online tool to permit access to all information (for state regulators, Tribal governments)
From the FNPRM:
Seeks to eliminate five sets of current requirements: 1) outages; 2) unfulfilled service requests; 3) number of complaints; 4) pricing; 5) compliance with service quality standards
What are regulatory costs incurred in producing this information?